The strengthening case to dump bank execs' bonuses

Bad PR is now so common in the banking industry that no one even flinched when Commonwealth Bank got another dose of it this week.

But the CBA board's actions over executive bonuses, approved by shareholders at last week's AGM, have set the banking industry up for years of being laughed at whenever it raises the issue. At the same time, the incident has raised questions about shareholder oversight of boards.

Many executive pay issues get distorted in the public debate. People who would never dream about complaining about the pay packets of actor Nicole Kidman or footballer Garry Ablett get upset about the pay of CEOs who earn the same money for being in charge of tens of thousands of employees and billions of dollars of retirement savings. There's plenty of evidence that top management quality does affect shareholder returns. The mere fact of a well-paid CEO should not be a cause for distress.

But last week's CBA fiasco was something else: an embarrassing handout to the CBA's leaders, with no decent justification.

The facts of the issue are straightforward. CBA executives were promised bonuses if they met certain targets, including finishing amongst the top three banks for customer satisfaction. CBA finished fourth, but the board decided the executives should have $8.5 million of the bonuses anyway.

For anyone who takes executive remuneration issues seriously, Turner's dog-ate-my-homework explanation at the AGM was strikingly, painfully awful:

"This year, in the year to June 2011, there was an anomaly and it started last November. On Melbourne Cup Day last year, the executive team implemented an out-of-cycle interest rate rise... And the increase was essential; it was essential to recover increased costs of wholesale funding that had already occurred.

"The executive team knew perfectly well that this would have a bad impact on customer satisfaction but they were convinced that it was in the best interests of shareholders."

He added that had the CBA skipped the bonus payments …

"... Ridiculously, it might also have confirmed people's worst fears that we were more concerned about customer satisfaction than about the good results of the group."

At which point, a few in the crowd might have wondered: if the CBA chairman is willing to publicly describe as "ridiculous" the idea of putting CBA customers' satisfaction above short-term results, should he speak publicly for the bank at all?

A few in the audience might have had other questions. Such as:

• If the CBA board and its remuneration committee hadn't thought about scenarios like this, is it time to look for better board members?
• If the bank's executive team couldn't anticipate the occurrence of "anomalies", are they really as smart as the board reckons they are?
• If a fourth-place customer satisfaction ranking could be tossed aside, why did the board make it a target in the first place?
• If pursuing shareholders' interests trumps everything else, why not just adjust people's pay packets based on their performance?
• How seriously will the executive team themselves take future bonus targets, now they know that "it was in the best interests of shareholders" is an acceptable excuse for missing them?
• When executives miss targets and get their shares anyway, what does that do to staff morale outside the executive team?
• If it's vital to pay the bonuses to keep the executive team happy, isn't the CBA back paying the market price for its talent - in which case, why not just pay the market price to begin with?

None of this mattered at the CBA meeting; just 13 per cent of the votes were cast against the remuneration report.

But the rest of the industry faces some harsh questions too. Will the industry's leaders ever be taken seriously again when they talk about the importance of bonuses in incentivising their leadership team? And how much bad publicity can the industry inflict on itself before it provokes another round of political intervention?

In an outstanding paper last year, PricewaterhouseCoopers Australia argued strongly for ending this farce and going back to a simple pay-plus-shares model, with the shares to be held for at least five years. There may be some tax issues here, but it should be possible to deal with them.

"The time has come for remuneration committees to ask some hard questions about their incentive programs," the paper concluded.

PWC ruefully noted that their preferred solution "may be a step too far for the current Australian environment". They should know; they're CBA's auditors.

But bank shareholders have every reason to push for best practice on executive remuneration. Shareholders have every reason to prefer board members who will ditch complex performance hurdles and bonus schemes.

And shareholders should ask this question. If boards cannot think clearly and objectively about a relatively simple issue like executive pay, what else are they overlooking, miscalculating or just plain messing up?